Capital Gain Calculation: Cost of Acquisition & Improvement under Section 55 of Income Tax Act 1961

Meaning and Calculation of Cost of Acquisition under Income Tax Act for Capital Gain Calculation

Cost of Acquisition is the total amount spent for acquiring the asset. Where the asset was purchased, the cost of acquisition is the amount paid to acquire it. Where the asset is acquired by way of exchange, the cost is the fair market value of that other asset as on date of exchange. Any expenditure incurred in connection with such purchase or exchange or other transaction ex. brokerage paid, registration charges and legal expenses form part of cost of acquisition.

Meaning and Calculation of Cost of improvement under Income Tax Act for Capital Gain Calculation

Cost of Improvement mean all expenditure of capital nature incurred in making additions or alterations to the capital asset. However, any expenditure which is deductible in computing the income under the heads Income from House Property, Profits and gains from Business and Profession or Income from other sources would not be taken as Cost of Improvement. Cost of Improvement for Goodwill of a business, right to manufacture, produce or process any article or thing or right to carry on any business is NIL.

CASE STUDY AND CALCULATION METHOD 

Mr Raj Purchase the property i.e. plot of land with constructed the ground floor on the land. After 2 years he decided to create increase the height of boundary wall from 2.5 feet to 8 feet  for privacy. After 2 years with increase in the size of family he decided to construct first floor. 2 years later ram got transferred to another city he sold the home.

COST OF INFLATION INDEX FOR LAST 34 YEARS FOR CAPITAL GAIN CALCULATION 

IMPORTANT CASE LAWS RELATED TO CAPITAL GAIN COST OF ACQUISITION AND COST OF IMPROVEMENT

Date of acquisition is relevant – The cost of acquisition of the capital asset mentioned in section 48 implies date of acquisition, and the date of acquisition of the asset is crucial for determining the capital gain – Syndicate Bank Ltd. v. Addl. CIT [1985] 155 ITR 681 (Kar.).

Cost of property received on partition is cost on date of partition – Cost of an asset to a divided member must necessarily be its cost to him at the time of partition – Kalooram Govindram v. CIT [1965] 57 ITR 335 (SC).

Cost must be as on the date of acquisition – Where the property was not a capital asset on the date of acquisition but subsequently became a capital asset (like when it happens when agricultural land is converted into non-agricultural use) prior to its sale, the cost of acquisition must be only with reference to its date of acquisition, and not with reference to the date on which it became a capital asset – Ranchhodbhai Bhaijibhai Patel v. CIT [1971] 81 ITR 446 (Guj.)/ CIT v. M. Ramaiah Reddy [1986] 158 ITR 611 (Kar.)/ CIT v. Smt. M. Subaida Beevi [1986] 160 ITR 557 (Ker.).

Where agricultural lands are converted into housing sites and sold, cost of acquisition of lands is their original cost and not market value on date of conversion – Where the assessee converted agricultural lands owned by him into housing sites and sold the sites, the cost of acquisition of the lands for purposes of computation of capital gains will be their original cost, and not the market value on the date of their conversion into housing sites. The principles laid down by the Supreme Court in Bai Shirinbai K. Kooka [1962] 42 ITR 86 cannot be invoked, since those principles do not apply to provisions relating to capital gains – M. Nachiappan v. CIT [1998] 230 ITR 98 (Mad.).

Events subsequent to date of acquisition are not relevant – While computing the capital gains, the assessee is concerned with the cost of acquisition, that is, the price which was paid by the assessee for acquiring the capital asset on the date it was acquired, subject to such adjustments as laid down under section 55. The assessee has no concern with what would be the value of that asset on some subsequent occasion; in other words, subsequent events need not be taken into consideration – CIT v. Steel Group Ltd. [1981] 131 ITR 234 (Cal.).

Mortgage expenses are not excludible – Where the assessee purchased a property and on the very date of purchase mortgaged the property in order to pay the vendor and for meeting the cost of stamp duty on the sale deed, and later sold the property, the mortgage expenses incurred in connection with the acquisition of the property as well as interest payable on the mortgaged amount would form part of the cost of acquisition of the property for the purpose of computation of capital gains. The fact that the mortgage was executed after the sale deed was obtained even though both the documents were signed and registered on the same day does not render the mortgage and the borrowing made thereunder irrelevant to the task of determining the cost of acquisition – CIT v. K. Raja Gopala Rao [2001] 252 ITR 459 (Mad.).

Shares thrown into family hotchpot – Where shares are thrown by the karta of a HUF in the family hotchpot, the cost of acquisition of the shares to the HUF for the purpose of computing capital gains arising from the sale of those shares by the HUF would be the market value of the shares as on the date on which the HUF acquired them, namely, the date on which the shares were throw into the common hotchpot by the karta – Smt. Sushilaben Kantilal Shah v. CIT [1994] 208 ITR 912 (Guj.).

Substitution of fair market value

Provision applies only if there is cost of acquisition – The effect of section 55 is that whatever be the cost during the period preceding 1-1-1964 (now 1-4-1981), the assessee may exercise the option of having the value ascertained as on that date. This provision cannot be pressed into service where there is no cost of acquisition at all – CIT v. Markapakula Agamma [1987] 165 ITR 386 (AP)/ CIT v. H.H. Maharaja Sahib Shri Lokendra Singhji [1986] 162 ITR 93 (MP).

Whether provision applies to depreciable assets – The option under section 55(2)(ii) would not be available to assets on which depreciation had been allowed, in view of the special provisions contained in section 50 – CIT v. Commonwealth Trust Ltd. [1982] 135 ITR 19 (Ker.)(FB). (per contra)

There is nothing in section 50(1), read with section 48(ii), which would confine the wide scope of section 55(2)(i) to the case of non-depreciable assets only where the assessee has acquired them by purchase – Goculdas Dossa & Co. v. J.P. Shah, Second ITO [1994] 75 Taxman 449 (Bom.)(FB).

Option must be exercised by assessee only – The authorities under the Act have no jurisdiction or power to direct the ascertainment of the cost of acquisition of a capital asset on the basis of the fair market value as on 1-1-1964 (now 1-4-1981), unless the assessee exercises such option, as the option is given to the assessee (and not to the departmental authorities) whether to adopt the cost of acquisition of asset to the assessee or the fair market value of the asset as on 1-1-1964 (now 1-4-1981) – CIT v. Duncan Bros. & Co. Ltd. [1994] 209 ITR 44 (Cal.).

Option can be exercised at any time before capital gain is computed – Section 55(2)(i) gives an option to the assessee to adopt as the cost of acquisition either the original cost or the fair market value as on 1-1-1981. The right of choice is conferred on the assessee solely for its benefit and in the absence of anything to the contrary in the enactment, such a right cannot be curtailed. The freedom of choice is available to the assessee till the income chargeable under the head ‘Capital gains’ is computed. The assessee can justifiably contend that he can exercise the option after both the figures, viz., the original cost and the fair market value of the asset as on 1-1-1981, are available – P.N.B. Finance Ltd. v. CIT [2001] 252 ITR 491 (Delhi).

Provision applies even if asset has cost nothing to the assessee – The expression ‘became the property of the assessee’s need not be confined to acquisition of the property by the assessee from a third party or acquisition for some price paid – CIT v. Daulatran Nayar [1976] 105 ITR 843 (Bom.).

Subsequent issue of bonus shares will have no effect – The cost of acquisition of the original shares is immutable. It can be either the actual cost of acquisition or, at the option of the assessee, the market value thereof on 1-1-1974 (now 1-4-1981). Once the assessee elects to adopt this latter market value, subsequent issue of bonus shares would have no effect on the cost of acquisition of the original shares, and the capital gains on transfer of such original shares has to be calculated on such cost – CIT v. Pormutit Body Ltd. [1994] 73 Taxman 560 (Cal.).

No separate value should be allotted to bonus shares where entire block of shares has been sold – No separate value should be allotted to the bonus shares where the entire block of shares has been sold and the whole cost of original shares including the bonus shares being a known figure, it would be unnecessary to ascertain the individual cost of each share – T.S. Srinivasan v. CIT [2000] 244 ITR 443 (Mad.).

Cost of improvement

Expenses must have actually been incurred – Only those expenses which have been actually incurred by the assessee in making additions and improvements in the property ought to be taken into consideration as ‘cost of improvement’ while computing capital gains under section 55(1)(b) of the Act – Shri Parmanand Bhai Patel & Smt. Jyotsna Devi Patel v. CIT [1984] 149 ITR 80 (MP).

Betterment charges are allowable – The expenditure in the shape of betterment charges paid under the town planning scheme for acquiring an enduring benefit are in the nature of capital expenditure and go to improve the value of the land, hence, they would fall under section 48(ii) – Mathurdas Mangaldas Parekh v. CIT [1980] 126 ITR 669 (Guj.).

Assessee must make a specific claim – It is necessary that before the provisions of section 48 can be called in aid for purposes of deduction of any costs incurred by the assessee on the improvement of the asset, the assessee must not only claim that he has made any such capital expenditure but also demonstrate that any such expenditure could possibly have been incurred by him for purposes of making an improvement to the asset in question – Emerald Valley Estates Ltd. v. CIT [1996] 88 Taxman 335 (Kar.).

Intangible assets can have no cost of improvement – In the case of intangible assets the additions cannot be physical. Therefore, it is not possible to say in every case that without any physical addition to the capital asset, there can be no improvement thereto. Whether physical addition is necessary or not will depend on the nature of the asset – Smt. S. Valliammai v. CIT [1981] 127 ITR 713 (Mad.) (FB).

Mortgage after purchase cannot constitute an improvement to asset – If subsequent to the purchase of the property by the previous owner, it was mortgaged by him and that mortgage was later discharged either by himself or by his successor-in-interest, that would not constitute an improvement to the capital asset which became originally the property of the previous owner – Ambat Echukutty Menon v. CIT [1978] 111 ITR 880 (Ker.).

Improvement must be on the asset itself and not on title to asset – The word ‘thereto’ in the expression ‘cost of any improvement thereto’ in section 55(2) would appears to cover a case where the amount is expended on the asset itself. Improving the owner’s title to the asset is different from improving the asset itself. Therefore, the amount paid as and by way of settlement of a claim to the person who disputed the title of the assessee cannot be said to be an expenditure by way of any improvement to the asset as such – CIT v. V. Indira [1979] 119 ITR 837 (Mad.).

Improvement to rubber trees – Expenses incurred by way of manuring, spraying, weeding, etc., in respect of rubber trees are really expenses incurred in connection with the cultivation and incidental thereto. They cannot be called ‘improvement’ as envisaged in section 55 – Travancore Rubbers Ltd. v. CIT[1990] 51 Taxman 355 (Ker.).

Compensation paid to tenants for vacating premises – Where the assessee sold a property to the Bombay Municipal Corporation, and paid compensation to the hutment dwellers for vacating the land, the amount so paid was allowable as ‘cost of improvement’ in the computation of capital gains, since by eviction of the hutment dwellers the value of the land increased – CIT v. Miss Piroja C. Patel [2000] 242 ITR 582 (Bom.).

S. 55 of the IT Act, 1961—Capital gains—The only condition which must be satisfied in order to attract the charge to tax under s. 45 is that the property transfered must be capital asset on the date of tranfer and that it is not necessary that it should have capital asset also on the date of its acquisition by the assessee—Arun Sunny vs. Dy. CIT

S. 55 of the IT Act, 1961—Capital gains—The only condition which must be satisfied in order to attract the charge to tax under s. 45 is that the property transfered must be capital asset on the date of tranfer and that it is not necessary that it should have capital asset also on the date of its acquisition by the assessee—Arun Sunny vs. Dy. CIT

S. 55 of IT Act, 1961—Capital gains—After calculating the average cost of bonus shares which are included in the total holding consisting of original shares and bonus shares, the average cost of original shares must inevitably get reduced pro tanto. There are two consequences if the principal of averaging, namely; (i) to attribute to the bonus share a cost when for that share there is no actual cost of acquision, and (ii) to reduce the actual cost of the original share to the extent that a notional cost is attributed to the bonus share. In other words, the cost of the original share will be reduced pro tanto to the extent of the cost attributed to the bonus share—M.B. & Co. Ltd. vs. ACIT

S. 55 of IT Act, 1961—Capital gains—The guideline value collected from the sub-registrar office is one among the guiding factors and such guideline values need not be the market value all the time. The market value is determined by so many external factors including the prevalent market conditions. Experience and wisdom are very precious and at the same time, it is necessary to bring on record certain parameters based on which it is possible for anybody to say that the value has been worked out on the basis of certain materials. Mentioning the location of the property alone is not sufficient. Since there is no case of any comparable sales or any other relevant information which would support the value adopted by the approved valuer, it is not possible to uphold the fair market value adopted by the such valuer as well as the assessee—ITO vs. Smt. Usha Ramesh (2011) 133 ITD 67 (ITAT-Chennai)

Limitation Act, section 5—Condonation of Delay—Circular of Central Board of Direct Taxes dated 27.3.2000—While dismissing the application as well as appeal, the Rajasthan High Court held that:—Simply because at a belated hour department has taken decision to file the appeal, it cannot be said that if furnishes any sufficient ground to the appellant to seek condonation of delay. CIT Vs. D.M.R.A.W.A. Trust (Raj.)…..260

S. 55 of IT Act, 1961—Firm—Once the claim of the assessee for the previous year had not been determined finally in the appeal before the return for the assessment year in question was filed, there is no occasion for the assessee to claim the benefit thereof at the time of filing return. Sec. 155 of the Act enables an assessee to move an application for rectification under s. 154 of the Act in case there is a change in the income of the firm—Naranjan Singh vs. ITO (2009) 311 ITR 362 (P&H)

S.48, 54F, 55 of IT Act, 1961 — Capital gains — Sec.54 of the Act exempts capital gain to the extent that consideration is paid for the purpose of a residential house. Where assessee has acquired one residential house consisting of two flats, it cannot be said that the assessee has purchased two residential houses. — CIT Vs. Raman Kumar Suri.

S.45, 48 & 55(2)(a), of IT Act, 1961 — Capital gains — Amendment to sec.55(2)(a) w.e.f. 1st April, 2002, brings self generated intangible assets as trade mark to capital gains tax only w.e.f asst. year 2002-03 onwards. Therefore, the sale of self generated trade marks during the asst. year 1999-2000 is not chargeable to capital gains tax. — CIT Vs. Fernhill Laboratories & Industrial Establishment [2012] 254 CTR 357 (Bom)

S.55, r/w S.2(47), 45 and 48, of IT Act, 1961 — Capital gains — In case of acquisition of tenancy rights, unless the costs thereof can be ascertained there would be no question of charging capital gain tax. — Amora Chemicals (P.) Ltd. Vs. CIT

S.2(22B), 45, 48 & 55(2)(b)(i) of  IT Act, 1961 — Capital gains — ‘Fair market value’ envisage existence of a hypothetical seller and a hypothetical buyer in a hypothetical market. Consideration as shown in the registered sale deed cannot be equated with ‘fair market value’, as defined in the Act under s.2(22B) of the 1961 Act. Therefore adoption of average value of the land in question at Rs.27,030 per acre on 1st April 1981, as ‘fair market value’ of the land for the purpose of computation of capital gains, is not legally and factually tenable. ‘Fair market value’ represents the price that a seller is willing to accept and a buyer is willing to pay in the open market. —  Manjit Singh Vs. Dy. CIT [2013] 151 TTJ (UO) 1 (ITAT-Chd)

S.2(14) 45, 55 of IT Act, 1961 — Capital gains — Under s.15A, inserted by the Maharashtra Act, 17 of 1973, certain licensees in occupation on February 1, 1973 would become tenants. By the provisions of s.55(2) of IT Act, tenancy rights have been considered to be a capital asset. The assessee was enjoying possession of the property and for peaceful vacation thereof it had received the amount which was described by the parties as amount paid for surrender of tenancy rights. The rights of the assessee is undisputed and the nature thereof is “property of any kind” which is held by the assessee and thus is a capital asset within the meaning of s.2(14) of the Act and, therefore, the amount received by the assessee is assessable under the head “capital gains”. — Kewal Silk Mills Vs. A. CIT [2013] 21 ITR 121 (ITAT-Mum)

S. 55 of IT Act, 1961—Capital gains—Amendment made of s. 55(2)(a) by bringing in terms ‘trademark’ and ‘brand name’ is only prospective and applicable from assessment year 2002-03—Kwality Biscuits (P.) Ltd. vs. ACIT (2012) 135 ITD 35 (ITAT-Banglore)

S.48, 50C & 55(2)(a) of IT Act, 1961 — Capital gains — As s.50C applies only to a capital asset, being land or building or both, it cannot be made applicable to lease rights in a land. Assessing Officer has not taken into consideration the objections of assessee while invoking the provisions of s.50C. Under s.50C(2), the Assessing Officer has to give an opportunity to assessee to make submissions. Since this exercise has not been done by the Assessing Officer and the Assessing Officer has to follow the provisions of s.50C(2) of the act when the provisions of s.50C are made applicable, the matter deserves to be remitted to Assessing Officer for fresh consideration. — Shavo Norgren (P) Ltd. Vs. Dy. CIT (2013) 152 TTJ 482 (ITAT-Mum)

S.48 & 55(2)(a) of IT Act, 1961 — Capital gains — The provision of s.55(2)(a)(ii) would not be applicable while valuing the “cost of acquisition” of the land for the purpose of computation of “long-term capital gain” of the assessee. Accordingly, the value of the leasehold rights in the land in question has to be determined in accordance with the provision of s.48 by determining the “fair market value” of the land as on 1st April, 1981 and the indexed cost of acquisition has to be determined in order to assess long-term capital gains in the hands of the assessee. — Natraj Vs. Dy. CIT (2013) 152 TTJ 619 (ITAT-Ahd)

S. 45, 55(2) of IT Act, 1961—Capital gains—For interpreting the facts of the case in hands in the light of the amended law, where the “tenancy rights” attained legal cognizance vide the amended s. 55(2), there is need for first deciding if the assessee’s right in the property constitutes a “tenancy rights” within the meaning of s. 55(2) of the Act.—Kishori lal Basanti Lal Patodia Vs. A. CIT. [2013] 23 ITR (Trib) 42 (ITAT-MUM)

S. 55, 131 of IT Act, 1961—Capital Gains—Sec. 55 mandates that valuation to be taken as “nil” in the case of a self-acquired asset which includes the amount paid on termination of tenancy.—P. Kunhiraman Nair Vs. CIT. [2013] 354 ITR 141 (KER)

S. 28(va), 55(2) of IT Act, 1961 — Capital gains or business income — Sec.28(va), inserted by the Finance Act, 2002, w.e.f. April 1, 2003, Provides that any sum, whether received or receivable, in cash or kind, under an agreement, for not carrying out any activity in relation to any business, or not sharing any know-how or technique likely to assist in the manufacture or processing of goods or provision for services is chargeable to tax under the head “Profits and gains of business or profession”. Prior to this amendment, which came into force w.e.f. April 1, 2003, the amount was not chargeable to tax either under s.28 or under any other provisions of the Act. Therefore, the amount received by the assessee prior to April 1, 2003, towards non-competition fee is not taxable — CIT Vs. Sunil Kini K. [2013] 354 ITR 623 (Karn)

Reference: – As Per Section 55 of the Income Tax Act 1961

Meaning of “adjusted”, “cost of improvement” and “cost f acquisition”.

5.  (1) For the purposes of [sections 48 and 49],—

(a) “Cost of any improvement”,—

(1) In relation to a capital asset being goodwill of a business or a right to manufacture, produce or process any article or thing] [or right to carry on any business shall be taken to be nil; and

(2) In relation to any other capital asset,—

(i) where the capital asset became the property of the previous owner or the assessee before the 1st day of April, 1981, means all expenditure of a capital nature incurred in making any additions or alterations to the capital asset on or after the said date by the previous owner or the assessee, and

(ii) in any other case, means all expenditure of a capital nature incurred in making any additions or alterations to the capital asset by the assessee after it became his property, and, where the capital asset became the property of the assessee by any of the modes specified in sub-section (1) of section 49, by the previous owner,

But does not include any expenditure which is deductible in computing the income chargeable under the head “Interest on securities”, “Income from house property”, “Profits and gains of business or profession”, or “Income from other sources”, and the expression “improvement” shall be construed accordingly.

Meaning of “adjusted”, “cost of acquisition”.

55(2) [For the purposes of sections 48 and 49, “cost of acquisition”,—

(a) in relation to a capital asset, being goodwill of a business [or a trade mark or brand name associated with a business] [or a right to manufacture, produce or process any article or thing] [or right to carry on any business], tenancy rights, stage carriage permits or loom hours,—

(i) in the case of acquisition of such asset by the assessee by purchase from a previous owner, means the amount of the purchase price ; and

(ii) in any other case [not being a case falling under sub-clauses (i) to (iv) of sub-section (1) of section 49], shall be taken to be nil ;

(aa) [in a case where, by virtue of holding a capital asset, being a share or any other security, within the meaning of clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) (hereafter in this clause referred to as the financial asset), the assessee—

(A) becomes entitled to subscribe to any additional financial asset ; or

(B) is allotted any additional financial asset without any payment,

then, subject to the provisions of sub-clauses (i) and (ii) of clause (b)],—

(i) in relation to the original financial asset, on the basis of which the assessee becomes entitled to any additional financial asset, means the amount actually paid for acquiring the original financial asset ;

(ii) in relation to any right to renounce the said entitlement to subscribe to the financial asset, when such right is renounced by the assessee in favour of any person, shall be taken to be nil in the case of such assessee ;

(iii) in relation to the financial asset, to which the assessee has subscribed on the basis of the said entitlement, means the amount actually paid by him for acquiring such asset ;

(iiia) in relation to the financial asset allotted to the assessee without any payment and on the basis of holding of any other financial asset, shall be taken to be nil in the case of such assessee ;] and

(iv) in relation to any financial asset purchased by any person in whose favour the right to subscribe to such asset has been renounced, means the aggregate of the amount of the purchase price paid by him to the person renouncing such right and the amount paid by him to the company or institution, as the case may be, for acquiring such financial asset ;]

(ab) in relation to a capital asset, being equity share or shares allotted to a shareholder of a recognised stock exchange in India under a scheme for6[demutualisation or] corporatisation approved by the Securities and Exchange Board of India established under section 3 of the Securities and Exchange Board of India Act, 1992 (15 of 1992), shall be the cost of acquisition of his original membership of the exchange:]

[Provided that the cost of a capital asset, being trading or clearing rights of the recognised stock exchange acquired by a shareholder who has been allotted equity share or shares under such scheme of demutualization or corporatization, shall be deemed to be nil;]

(b) in relation to any other capital asset,—]

(i) where the capital asset became the property of the assessee before the [1st day of April, [1981]], means the cost of acquisition of the asset to the assessee or the fair market value of the asset on the [1st day of April, [1981]], at the option of the assessee ;

(ii) where the capital asset became the property of the assessee by any of the modes specified in [sub-section (1) of] section 49, and the capital asset became the property of the previous owner before the [1st day of April, [1981]], means the cost of the capital asset to the previous owner or the fair market value of the asset on the [1st day of April, [1981]], at the option of the assessee ;

(iii) where the capital asset became the property of the assessee on the distribution of the capital assets of a company on its liquidation and the assessee has been assessed to income-tax under the head “Capital gains” in respect of that asset under section 46, means the fair market value of the asset on the date of distribution ;

(iv) where the capital asset, being a share or a stock of a company, became the property of the assessee on—

(a) the consolidation and division of all or any of the share capital of the company into shares of larger amount than its existing shares,

(b) the conversion of any shares of the company into stock,

(c) the re-conversion of any stock of the company into shares,

(d) the sub-division of any of the shares of the company into shares of smaller amount, or

(e) the conversion of one kind of shares of the company into another kind,

means the cost of acquisition of the asset calculated with reference to the cost of acquisition of the shares or stock from which such asset is derived.]

(3) Where the cost for which the previous owner acquired the property cannot be ascertained, the cost of acquisition to the previous owner means the fair market value on the date on which the capital asset became the property of the previous owner.